Every business owner must eventually retire. Many will pass on their business to their sons or daughters, others will sell up to a third party. If the sale is not executed correctly, the business owner could face a large, and mostly unnecessary, tax bill.

So how can you minimise your tax bill when selling a business?

Most businesses are contained within companies in which the business owner holds shares. Buyers tend to want asset deals to buy the business directly from the company, but sellers generally prefer to sell shares in the company.

For the seller, the key driver is the desire to achieve a sale that is taxed at only 10 per cent by utilising Business Asset Taper Relief (BATR). If a business is contained within a company, this tax rate can only be achieved by selling shares.

The buyer may prefer an asset deal, in which they acquire none of the historic attributes of the company, tax or otherwise. If the buyer is a company, it can deduct any goodwill paid on the acquisition of the business against its future corporate tax liabilities.

However, an asset sale is potentially disastrous for the seller, as it is taxable in the seller’s company and liable for corporation tax at 30 per cent. The sale proceeds will be received by the company, not the seller, and a minimum of 10 per cent extra tax will be payable when stripping the sale proceeds out of the company into the seller’s hands.

All told, the seller could face a tax bill of at least 40 per cent of the sale proceeds by agreeing to an asset sale, whereas a share sale should result in a tax bill of only 10 per cent of the sale proceeds.

The BATR option has a number of conditions attached. The main condition is that the owner has held share in a ‘trading company’ for at least two years. The definition of a trading company, and the Inland Revenue’s approach to applying it, is where problems frequently arise, especially where companies hold large cash balances. Tax rules define a trading company as “a company carrying on trading activities whose activities do not include to a substantial extent activities other than trading activities”.

The Revenue interprets substantial as more than 20 per cent. If the value of non-trading assets is higher than 20 per cent of total assets, the status of the company, and the availability of BATR, are affected.

To protect their position, owner managers should remember that the 20 per cent limit only relates to excess cash. Arguing that additional cash is needed as working capital, or that it is earmarked for specific expansion or acquisitions, can justify the cash retained.

A regular and constant review of the company’s activities should ensure that where possible any non-trade assets, including excess cash, are kept within the 20 per cent limit.

Timing of any sale is important in establishing when the resulting tax liability is payable. If the shares in the business are sold on or after April 6, the owner’s capital gains tax bill is payable on January 31 in two years’ time. However, if the shares are sold before April 6, that bill is payable on the next January 31.

Selling a business is fraught with tax complications and tax pitfalls, and is likely to be scrutinised in detail by the Inland Revenue. However, provided the seller obtains professional tax advice and negotiates in a tax informed manner with the buyer, it should be possible to obtain a tax rate of only 10 per cent of the sale proceeds. l

Andrew Shilling is a chartered accountant, a chartered tax advisor, and head of M&A Tax Services at tax consulting firm Chiltern.